Question

1. Three major approaches to analyzing the economic impact of currency depreciation are (1) the elasticities approach, (2) the absorption approach, and (3) the monetary approach.

Which of the following accurately defines and distinguishes one of these approaches?

A. According to the elasticities approach, over the long run, depreciation merely raises the domestic price level.

B. According to the elasticities approach, currency depreciation leads to the greatest improvement in a country’s trade position when demand elasticities are high.

C. According to the absorption approach, over the long run, depreciation merely raises the domestic price level.

D. According to the monetary approach, a depreciation merely lowers the domestic price level.

2. Complete the following statement explaining the effect of complete currency pass-through on a nation whose currency depreciates.

Import and export prices in a nation’s currency will change __________ ( less than or more than or proportionately to) the currency depreciation.

3. An appreciation of the U.S. dollar tends to: ______

a. Discourage foreigners from making investments in the United States

b. Discourage Americans from purchasing foreign goods and services

c. Increase the number of dollars that could be bought with foreign currencies

d. Discourage Americans from traveling overseas

Answer 1

1.Answer: B. According to the elasticities approach, currency depreciation leads to the greatest improvement in a country’s trade position when demand elasticities are high.

During currency depreciation , the value of one currency falls in relation to other currency i.e ) you need to pay more to receive the other currency. When an incident happens, exports in the currency depreciated country increases( due to to fall in its value ). Whereas its imports decreases .Thus , the country in the currency depreciated currency gains and improves its trade position. The Elasticity approach to the balance of payments demonstrates how the change in the value of the currency affects a country's balance of payments.

2. Import and export prices in a nation’s currency will change Proportionately to the currency depreciation.

During currency depreciation , the value of one currency falls in relation to other currency i.e ) you need to pay more to receive the other currency. When an incident happens, exports in the currency depreciated country increases( due to to fall in its value ). Whereas its imports decreases .

Example:- If 1 US $ = 70 INR, if the value of INR depreciates, then more INR has to be paid to receive 1 US$. So , it may be 73 INR = 1 US$. This causes the US to buy more goods from India ( because its cheaper), thus Indian exports increases. But for India, this currency depreciation process will lead to fall in imports, as they need to pay more to get the same good. Thus , imports and export prices change proportionately to the change in currency depreciation.

3.a. Discourage foreigners from making investments in the United States

Refer above example. As the foreigners  have to pay more to get the same good or service , it discourages investments/purchases by foreigners.